The EU ETS was established by Directive 2003/87/EC (the “Directive”) and linked to the Kyoto Protocol’s project mechanisms by Directive 2004/101/EC. It commenced operations in January 2005, and is the largest scheme for greenhouse gas (“GHG”) emission allowance trading world-wide.

The EU ETS is based on six fundamental principles: 

  • it is a “cap-and-trade” system 
  • its initial focus is on CO2 from big industrial emitters 
  • implementation is taking place in phases, with periodic reviews and opportunities for expansion to other gases and sectors 
  • allocation plans for emission allowances are decided periodically 
  • it includes a strong compliance framework 
  • the market is established by the EU ETS EU-wide but taps emission reduction opportunities in the rest of the world through the use of Clean Development Mechanisms (“CDM”) and Joint Implementation (JI), and provides for links with compatible schemes in third countries

The EU ETS is based on the allocation of GHG emission allowances (Allowances), which may be traded, to specific industrial sectors through national allocation plans (NAPs) subject to the approval and supervision of the European Commission. NAPs set out the overall emissions cap for each Member State and the Allowances that each sector and individual installation covered under the Directive receives.

The first phase of the EU ETS covers the period 2005-2007, while the second phase coincides with the Kyoto Protocol’s first commitment period, from 2008 to 2012. The first phase of the EU ETS applies to some 7,300 companies and 12,000 installations in six major industrial sectors across the enlarged EU. These industrial sectors include: utility combustion plants; oil refineries; coke ovens iron and steel plants; energy-intensive industry, such as cement, glass, lime, brick and ceramics production facilities; and the pulp and paper industries. In the first phase of the EU ETS, only Allowances in relation to CO2 will be issued; in the second phase, Methane (CH4); Nitrous Oxide (N2O); Hydrofluorocarbons (HFCs); Perfluorocarbons (PFCs) and Sulphur Hexafluoride (SF6) will be included in the EU ETS.

The trading system allows emitters who reduce emissions beyond their obligations to save unused allocations for future use or sell them to other companies that need a cost effective way of achieving their emission reduction targets. At present, carbon capture and storage (CCS) is not specifically recognised in the EU ETS as an activity giving rise to Allowances. In addition, CCS is not recognised at the international level as an emission reduction technology which qualifies as a Clean Development Mechanism under the Kyoto Protocol. This is largely due to concerns over boundaries, verification, permanence, leakage, the ability to account for carbon stored, and legal and regulatory issues. The EU Climate Change Programme’s Working Group on CCS is working to address these issues.